For non-tax people, it can be easy to consider a tax credit and a tax write-off to be one and the same. After all, both of them offer benefits on your taxes, ideally in the form of you paying less. In other words, they’re both good.
But to a tax professional, they are actually different and one is better than the other, though both are ideal.
What is a Tax Credit?
To put it as simply as possible, tax credits “…reduce taxes directly and do not depend on tax rates.” (Tax Policy Center)
In other words, if you have a $500 tax credit, then that’s $500 off of your taxes, no matter what your tax rate is.
What is a Tax Write-Off/Deduction?
As for a tax write-off or deduction, “The value of all deductions, itemized or otherwise, depends on the taxpayer’s tax liability and marginal tax rate.” (Tax Policy Center)
What that means is that the deduction is going to vary by what tax bracket you fall into. For example, if you have a $10,000 deduction, your taxes will be reduced by $1,200 if you’re in a 12% tax bracket, but $3,200 if you’re in the 32% tax bracket.
What’s Better, a Tax Credit or a Tax Deduction?
According to Investopedia, “Tax credits are more favorable than tax deductions or exemptions because tax credits reduce tax liability dollar for dollar. While a deduction or exemption still reduces the final tax liability, they only do so within an individual’s marginal tax rate.”
The other benefit comes if you have enough tax credits that your net liability drops below zero. “Some credits…are refundable, which means that you still receive the full amount of the credit even if the credit exceeds your entire tax bill.” (Turbo Tax)
When it comes to deductions, there are some deductions that can be rolled over to the next year, but deductions are often capped, which means it is difficult to drop your net liability below zero with deductions alone.
As a Business Owner, Why Do I Care?
Tax credits and tax deductions are independent of each other, which means that you are perfectly within your rights to take both on your taxes. It’s important that you remember to look into and take advantage of both as you do your taxes so that the system works for you instead of against you.
As always, the tax advice we provide in these blog posts is generic in an effort to apply to the most people possible. To get an idea about how your specific company can benefit, you should seek out the advice of a tax professional.
We here at The Tax Credit Group understand the ins and outs of the tax laws and how to make them best work to your advantage. Feel free to contact us at any time for a consultation.